Advanced financial accounting by baker chapter 10

Consolidated Statement of Cash Flows– Requires only a few adjustments such as those for depreciation and amortization resulting from the write-off of a differential beyond those used in

Additional Consolidation

Reporting Issues

10

General Overview

general financial reporting topics as they

relate to consolidated financial statements:

1 The consolidated statement of cash flows

2 Consolidation following an interim acquisition

3 Consolidation tax considerations

4 Consolidated earnings per share

Consolidated Statement of Cash Flows

similar to a statement of cash flows

prepared for a single-corporate entity and is prepared in basically the same manner

– Typically prepared after the consolidated

income statement, retained earnings statement, and balance sheet

– Prepared from the information in the other

Consolidated Statement of Cash Flows

– Requires only a few adjustments (such as

those for depreciation and amortization resulting from the write-off of a differential) beyond those used in preparing a cash flow statement for an individual company

– All transfers between affiliates should be

eliminated– Noncontrolling interest typically does not

cause any special problems

Consolidated Statement of Cash Flows for the

Year Ended December 31, 20X2 (Figure10–2)

Consolidated Statement of Cash Flows

method

– Nearly all major companies use the indirect

method– Critics have argued that the direct method is

less confusing and more useful

Consolidated Statement of Cash Flows

in approaches is the operating activities

section

– Under the indirect approach, the operating

activities section starts with net income and,

to derive cash provided by operating activities, adjusts for all items affecting cash and net

income differently– Under the direct approach, the operating

Consolidated Statement of Cash Flows

– Direct approach - As an example, the only

cash flows related to operations are:

– The remainder of the cash flow statement is

the same under both approaches except that

a separate reconciliation of operating cash flows and net income is required under the direct approach

Consolidation Following an Interim

Acquisition

fiscal period, the results of the subsidiary’s

operations are included in the consolidated statements only for the portion of the year

that the stock is owned by the parent

Consolidation Following an Interim

Acquisition - Illustration

Assume that on July 1, 20X1, Peerless Products purchases 80 percent of

Special Foods’ common stock for its underlying book value of $246,400 At the time of acquisition, the $61,600 fair value of Special Foods’ noncontrolling

interest is equal to its book value For the year 20X1, Special Foods reports

the following items:

Consolidation Following an Interim

Acquisition - Illustration

The book value of Special Foods’ stock acquired by Peerless on July 1, 20X1:

The ownership situation on July 1, 20X1:

Consolidation Following an Interim

Record purchase of Special Foods stock.

Entries during the second half of 20x1:

Investment in Special Foods Stock 14,400

Record dividends from Special Foods:

$18,000 x 80

Investment in Special Foods Stock 24,000

Record equity-method income:

$30,000 x 80

Consolidation Following an Interim

Acquisition - Illustration

Eliminating entries:

E(4) Income from Subsidiary 24,000

Dividends Declared 14,400 Investment in Special Foods Stock 9,600

Eliminate income from subsidiary.

E(5) Income to Noncontrolling Interest 6,000

Dividends Declared 3,600 Noncontrolling Interest 2,400

Assign income to noncontrolling interest, from July 1:

$6,000 = $30,000 x 20 $3,600 = $18,000 x 20 E(6) Common Stock—Special Foods 200,000

Retained Earnings, January 1 100,000

Cost of Goods Sold 46,000 Depreciation and Amortization 8,000 Other Expenses 6,000 Dividends Declared 12,000 Investment in Special Foods Stock 246,400 Noncontrolling Interest 61,600

Consolidation Following an Interim

Acquisition - Illustration

Consolidation Income Tax Issues

file a consolidated income tax return, or

they may choose to file separate returns

– For a subsidiary to be eligible to be included in

a consolidated tax return, at least 80 percent

of its stock must be held by the parent company or another company included in the consolidated return

Consolidation Income Tax Issues

– The losses of one company may be offset

against the profits of another – Dividends and other transfers between the

affiliated companies are not taxed– May make it possible to avoid limits on the

use of certain items such as foreign tax credits and charitable contributions

Consolidation Income Tax Issues

– Once an election is made to include a

subsidiary in the consolidated return, the company cannot file separate tax returns in the future unless it receives IRS approval – The subsidiary’s tax year also must be

brought into conformity with the parent’s tax year

– Can become quite difficult when numerous

Consolidation Income Tax Issues

consolidated return is filed

– Portrays the companies included in the return

as if they actually were a single legal entity– All intercorporate transfers of goods and

services and intercompany dividends are eliminated and a single income tax figure is assessed

Consolidation Income Tax Issues

– Because only a single income tax amount is

determined, income tax expense must be

assigned to the individual companies

– The method of tax allocation can affect the

amounts reported in the income statements of both the separate companies and the

consolidated entity

Consolidation Income Tax Issues

– When a subsidiary is less than 100 percent

owned, tax expense assigned to the

subsidiary reduces proportionately the income assigned to the parent and the noncontrolling interest

– The more tax expense assigned to the

subsidiary, the less is assigned to the parent; the income attributed to the controlling interest then becomes greater

Consolidation Income Tax Issues

Assume that Peerless owns 80 percent of the stock of Special Foods, acquired

at book value, and the two companies elect to file a consolidated tax return for 20X1 Peerless reports operating earnings before taxes of $140,000, excluding income from Special Foods, and Special Foods reports income before taxes of

$50,000 Consolidated income taxes are $76,000 ($190,000 x 40 percent tax rate)

Consolidation Income Tax Issues

when affiliates have significantly different

Consolidated income statement for 20X1 shows the following amounts:

Consolidation Income Tax Issues

return is filed

– Intercompany transfers are eliminated in

computing both consolidated net income and taxable income

– Because profits are taxed in the same period

they are recognized for financial reporting purposes, no temporary differences arise, and

no additional tax accruals are needed in

Consolidation Income Tax Issues

are filed

– The companies are taxed individually on the

profits from intercompany sales– No consideration is given to whether the

intercompany profits are realized from a consolidated viewpoint

Consolidation Income Tax Issues

are filed

– The tax expense on the unrealized

intercompany profit must be eliminated when the unrealized intercompany profit is

eliminated in preparing consolidated financial statements

– This difference in timing of the tax expense

recognition results in the recording of deferred

Consolidation Income Tax Issues

– This tax effect normally is carried to the consolidated

balance sheet as an asset – If the intercompany profit is expected to be recognized

in the consolidated income statement in the next year, the deferred taxes are classified as current

Special Foods sells inventory costing $23,000 to Peerless Products for

$28,000, and none is resold before year-end Assume 40 percent tax rate.

Eliminating entries:

Eliminate intercompany upstream sale of inventory.

Eliminate tax expense on unrealized intercompany profit.

Unrealized Profit in Separate Tax

3 The effective combined federal and state tax rate for both Peerless and

Special Foods is 40 percent.

Unrealized Profit in Separate Tax

Return Illustrated

Eliminating entries:

Eliminate income from subsidiary.

E(10) Income to Noncontrolling Interest 5,400

Assign income to noncontrolling interest.

Eliminate intercompany upstream sale of inventory.

Subsequent Profit Realization When

Separate Returns Are Filed

If income taxes were ignored, eliminating entry E(14) would be used in

preparing consolidated statements as of December 31, 20X2, assuming that

Special Foods had $5,000 of unrealized inventory profit on its books on

January 1, 20X2, and the inventory was resold in 20X2:

E(14) Retained Earnings, January 1 4,000

Noncontrolling Interest 1,000

Cost of Goods Sold 5,000

Eliminate beginning inventory profit.

Subsequent Profit Realization When

Separate Returns Are Filed

If the 40 percent tax rate is considered, eliminating entry E(15) is used:

Noncontrolling Interest 600 Income Tax Expense 2,000

Cost of Goods Sold 5,000

Eliminate beginning inventory profit:

$2,400 = ($5,000 - $2,000) x 80 $600 = ($5,000 - $2,000) x 20 $2,000 = $5,000 x.40

Consolidated Earnings Per Share

deducting income to the noncontrolling

interest and any preferred dividend

requirement of the parent company from

consolidated net income

– The resulting amount is then divided by the

weighted-average number of the parent’s common shares outstanding during the period

Consolidated Earnings Per Share

deducting income to the noncontrolling

interest and any preferred dividend

requirement of the parent company from

consolidated net income

– The resulting amount is then divided by the

weighted-average number of the parent’s common shares outstanding during the period

Consolidated Earnings Per Share

– While consolidated net income is viewed from

an entity perspective, consolidated earnings

per share follows a parent company approach and clearly is aimed at the stockholders of the parent company

Consolidated Earnings Per Share

earnings per share

Consolidated Earnings Per Share

– The parent’s share of consolidated net income

normally is the starting point in the computation of diluted consolidated EPS– It then is adjusted for the effects of parent and

subsidiary dilutive securities